Last Friday the JSE all-share index fell 4.02%. This resulted in panic among stock market investors. However, it’s crucial that this drop should be seen in context.
If you were the average stock market investor your funds were probably invested in a balanced fund with about 60% exposure to South African equities. The 4% drop on the JSE Securities Exchange would only have translated into a 2.4% dip in your balanced portfolio. The remainder of your balanced portfolio (cash, property and bonds) would have earned returns and would have further negated the losses.
If you were invested in a conservative fund, you would only have about 30% exposure to South African equities. The 4% drop on the JSE would have resulted in a 1.2% fall in your conservative portfolio. The remainder of your portfolio would have earned returns to negate the losses. Compare this with the returns of roughly 30% during the past few years and it really doesn’t amount to much.
Portfolio rebalancing helps you keep your stock market investments in line with your investment strategy. The idea behind rebalancing is to reduce risks created by the build-up of an excessive sum of money in any given asset class. Portfolio rebalancing is not an attempt to time the market, but rather the continuous implementation of an investor’s long-term strategy.
For example, an investor has R1m to invest. He decides to invest it in a balanced fund with 15% (R150 000) in bonds, 15% (R150 000) in property, 10% (R100 000) in cash and 60% (R600 000) in equities.
At the end of the year, the investor finds that the equity portion of his portfolio outperformed the other portions. This has caused a change in his initial allocation of assets, increasing the percentage that he has in the equity fund while decreasing the others.
The equity portion returned 35% over the last year and grew to R810 000. The cash portion returned 5%, resulting in a rand value of R105 000. The bond portion realised a loss of 5%, resulting in a rand value of R142 500 and the property portion remained level.
The overall return on the investor’s portfolio was approximately 20.75%, but now there is a higher percentage invested in equities than in bonds. The investor might be willing to leave the asset mix as is, but leaving it too long could result in an over-weighting in the equity fund, which is more risky than the bonds, property and cash.
A popular belief among many investors is that if an investment has performed well during the last year, it should perform well over the next year. However, past performance is neither a guarantee nor an indication of future performance. Investors must avoid succumbing to a herd mentality. This can be dangerous when the market changes.
Let’s compare the above situation if there was rebalancing and if there was no rebalancing.
At the end of the next year, the equity portion performs poorly losing 8%, bonds and property perform well returning 20% and 15% respectively and cash remains stable, returning 5%. If the investor rebalanced his portfolio, his total portfolio value would be R1 218 971, an increase of nearly 1%. If the investors left his portfolio alone with the skewed weightings, his total portfolio value would be R1 198 950, a negative return of nearly 1%. In this example, rebalancing is the optimal strategy as the return is more than R20 000.
However, if the stock market runs again in the following year, the equity portion would appreciate more and the portfolio where no rebalancing occurred may realise a greater appreciation.
It is best to consult your financial planner to determine the appropriate strategy for your stock market portfolio. Visit the Financial Planning Institute website at www.fpi.co.za to select a CERTIFIED FINANCIAL PLANNER®.
Debbie Netto-Jonker CFP® is the founder of Netto Financial Services and was Financial Planner of the Year in 2001.
